I am a Professor of Economics at Texas Christian University, where I have worked since 1987. My areas of specialty are international economics (particularly exchange rates), macroeconomics, history of economics, and contemporary schools of thought. During my time in Fort Worth, I have served as department chair, Executive Director of the International Confederation of Associations for Pluralism in Economics, a member of the board of directors of the Association for Evolutionary Economics, and a member of the editorial boards of the American Review of Political Economy, the Critique of Political Economy, the Encyclopedia of Political Economy, the Journal of Economics Issues, and the Social Science Journal. My research consists of over thirty refereed publications, two edited volumes, and one book (with another in process). I have also been lucky enough to win a couple of teaching awards.
In terms of my approach to this blog, I am a firm believer that economics can and must be made understandable to the general public, but that our discipline has done a very poor job in this regard. This is particularly true of macro issues, where people quite naturally assume that their personal experiences are analogous to those at the national scale. Very often, this is not the case, with the result that politicians and voters (and some economists) press for policies whose effects are quite the opposite of what was intended. That this is problematic has never been more evident than today. I also try to steer as clear of politics as possible. I want to explain how things work, not what you should believe.
I have been married to my wife, Melanie, for over twenty-five years, and we have twin daughters (who have just started college) and a dog named Rommel (who has not). My favorite pastimes are online computer gaming and reading about WWII history.

Money Growth Does Not Cause Inflation!

There is clearly a problem here which could be solved in one of three ways (assuming we don’t just lower M back to 200): 1) y could rise to 200, but of course it can’t because it’s already at its maximum; 2) V could fall to 2.5, but it is constant (something Friedman takes pains to emphasize in the original article); or 3) P could rise to 20. It is of course the third that proponents of the “money growth==>inflation” view say will occur.

MV = Py 400 x 5 = 20 x 100

Equality again!

Let me reemphasize why this is the only logical outcome. We have assumed that y and V are constant. Friedman says that y is constant at the level associated with the natural rate of unemployment, while V is indirectly related to agents’ demand for cash. When people want to hold more cash, V, the rate at which they spend cash, naturally falls, and vice versa. But, Friedman further specifies that V is relatively constant and so, therefore, is the demand for cash. Thus, when the central bank raised the supply of cash from 200 to 400, this meant that people were holding more cash than they wished to have in their portfolios. The Fed had created a situation in which the supply of money (newly raised) exceeded the demand (still at the original level). The result was that people, in the language of the “money growth==>inflation” view, rid themselves of excess money balances by spending that cash. They hoped to buy more goods and services but since, in aggregate, more did not exist, they only bid up their prices: money growth led to inflation.

This is this standard view. It makes for a great lecture in an intro or even intermediate macro class and I’ve done it many times (in fact, I just did it this week in my summer course). But the problem is that after the course is over, people only remember this:

increase M ==> increase P

What they don’t recollect are all the assumptions we made to get there! And not only are some questionable, they are downright inconsistent with other lectures we make in the very same class.

Take for example y. One need only look out the window to see that it is not currently at the full-employment and therefore maximum level. Hence, given this scenario:

MV = Py 400 x 5 > 10 x 100

there is no reason that this could not lead to the rise in y shown below as those spending their “excess money balances” actually cause entrepreneurs to raise output to meet the new demand:

MV = Py 400 x 5 = 10 x 200

This is, of course, the goal of the government deficit spending that so many economically-ignorant people are trying to stop right now.

In addition, there is a great deal of evidence that the velocity of money IS NOT constant. As one would expect, it tends to decline in recessions when people do, in fact, want to hold more cash. Hence, if we assume that the central bank undertakes the above policy during such a period (as we see today), the final result might be this:

MV = Py 400 x 2.5 = 10 x 100

Or it could be some combination of a rise in y and a fall in V–this would make perfect economic sense. Notice how the process of making the initial assumptions of this approach more realistic is making it far from certain that a rise in M leads to a rise in P, particularly during an economic downturn.

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Isn’t the Fed controlling inflation now by not including food or energy in core CPI? Ignore it and it will go away! Anyway your explanation makes perfect sense, especially to anyone familiar with the markets: commodity prices drive inflation. I’d be interested if you see a connection against relative values of currencies (foreign exchange) as a contributor to higher commodity prices — that is, a weaker dollar relative to other currencies means producers who sell their product in US dollars start demanding more dollars to retain their home country revenues stable, driving prices higher (this would be a secondary driver to fundamental supply/demand, of course)

Brendan: “Isn’t the Fed controlling inflation now by not including food or energy in core CPI? Ignore it and it will go away!”

Well said, Brendan. I agree completely.

Brendan: “Anyway your explanation makes perfect sense, especially to anyone familiar with the markets: commodity prices drive inflation. I’d be interested if you see a connection against relative values of currencies (foreign exchange) as a contributor to higher commodity prices — that is, a weaker dollar relative to other currencies means producers who sell their product in US dollars start demanding more dollars to retain their home country revenues stable, driving prices higher (this would be a secondary driver to fundamental supply/demand, of course).”

Actually, my specific area of research interest is exchange rates. I have a book on the subject (it’s largely an academic book, however, not sure of how much interest it would be to others):

I mention this so it won’t sound like a cop out when I say–it’s complicated! What you suggest can most certainly happen, but there is so much other crap going on (and not so much of it being “fundamental” since currency prices are essentially driven by financial markets–lots of psychology involved) that it is hard to filter it out. But trade flows are in general a secondary factor in moving exchange rates and those selling goods and services in the US are likely to also be concerned about protecting market share over profit margins. This happened when foreign firms made big inroads into the US market during the massive dollar run up through February 1985. When the dollar did an equally dramatic reversal (analogous to today’s experience), we did not witness a decline in those foreign sales–they were more concerned about protecting market share.

1. Inflation IS the expansion of the money supply and un-backed bank credit. The FED is the salient source of Inflation in the economy, creating new money directly and encouraging fraudulent credit expansion by the banks. 2. This debasement of the currency is only different in mechanism than the Roman debasement of the Denarius, which ultimately doomed Rome. 3. When there is no inflation, an expanding economy will see price declines as the relatively constant money supply is chasing more goods. 4. The FED and its apologists obfuscate the nefarious and insidious effects of inflation by using the term to mean increase in prices.

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Another eye-opening piece by Professor Harvey. As I explain this to the masses to get my point home (just yesterday again). “Let’s say I stack up a million dollars worth of $100 bills right here in my office. Close your eyes and visualize this. Now let me ask you – Is this inflationary?” Most of the time, respondents ask “well, if nobody takes it and spends it and it just sits here?” “Yes.” “Doesn’t appear to be.” “OK now I’m going to give you both a stack of these bills and spend it…now what?..” Sooner or later, my point hits home.

My velocity explanation to the masses not as eloquent as Dr. Harvey’s!! Excellent piece.

hoarded counterfeited money doesn’t increase the money supply. This was well described in the past century and is basic monetary theory. Meanwhile, this article is rubbish and the author only calling out those he can deal with or that agree with him.

Is that is what is happening? Money that is made out of thin air is just sitting in someone computer? Or is it being traded for good and services? What happens when the rest of the world comes to the US door step and ask for something in return? The problem I see is that the formula that is being used needs one more variable, The ‘X’ factor, where x is the money that is in holding that someone will eventually what something for it.

Thank you for excellent posting. Here ar Forbes.com it seemed that all bloggers were required prepare at least one blog about how inflation is caused by “too much money chasing too few goods” and how if the Federal Reserve could eliminate all inflation if they would “just stop printing money”. My response had always been empirical, the money supply, at least as measured by the M3 stock, had been falling for months all the while prices had rising. However, your description of the broadest principles of exactly how inflation works is so much more effective.

however, there is generally deflation on main st. and inflation in the casino economy (equities)

That’s because the Federal Reserve member banksters get the money created, and instead of loaning it out to people, speculate with it in equities and fraudulent derivative type investments. That’s why the stock market rises while real estate prices fall. Even though the mortgage backed securities are publically traded, your actual house isn’t. Hence the desparity between inflation on Wall st. and deflation on Main st.

Thank you, good article. It does not cause inflation directly, it entirely depends on all the surrounding factors, economic state of not only the US, which in this day and age are entirely too many to take into consideration in one article but well done. You should go ahead and write another book though.

No, it directly causes inflation, and a 5 year old can understand why. Imagine there are 3 people on planet earth. One person invents the concept of money, and so makes 10 paper certificates and explains to the other people he will echange this medium for goods, and accept them in return for goods. Sounds good so far. So buyer and seller #1 agree 1 certificate buys 100 tomatoes. The buyer pays the certificate, the seller accepts it for the tomatoes, and everyone is happy. The tomato seller uses the money cert. to buy a bushel of corn. The seller soon concludes he needs more money, but unlike the real world where labor and sale of goods results in a GREATER SHARE OF A FINITE AMOUNT OF MONEY this person simply prints up 10,000 more certificates! This represents no more GDP there are still the same amount of people, labor, tomatoes, corn, whatever. As the GDP remains constant or decreases, and money supply increases, inflation results. The seller is no longer content to accept 1 / 10,000 th of the wealth for his crop of tomatoes, because the buyer buys all the corn from the only seller with his counterfiet money. What is the tomato seller to do? His 1 certificate share of the wealth represents 1 / 10,000 th where he used to have 1 / 10 th! He has been robbed through inflation AKA money printing. Insert your numbers for population / GDP / certificates of money. The principle is exactly the same. The delusion enters where people can’t understand newly created wealth isn’t distributed evenly among the population (that would still resuilt in inflation, by the way) it would just be equitable instead of the money printer (FED) robbing everyone’s wealth.

John, great post, as always with you. You are a great communicator. I wonder whether in your future posts you would touch on how to best measure the inflation. It is a very hard problem and functional finance/MMT policy proposals depend heavily on our ability to monitor inflation. Now, as we know, there are many types of inflation, with leakages from one to another etc, so, this part is highly non-trivial.

My experience has been many people that believe “printing money” causes inflation actually are thinking about currency devaluation. Which isn’t an issue as you stated the Fed focuses on price vs quantity.

Interesting about your work on exchange rates but aren’t all commodities subject to the same “markets–lots of psychology” syndrome. Thinking about gold and silver.